We have had discussions earlier here on attracting great talent to startups, and what the key motivators are. Clearly, there are other motivators besides money in a startup decision – such as sense of purpose, role that one can play, and so on. However, the more I talk to entrepreneurs around, the more evident is the lack of a financial incentive that works.
Couple of weeks back, I was in a group of entrepreneurs for a closed-door discussion on this. There was near unanimity that employees do not value ESOP grants. There were still some people who were allocating ESOP, especially to early/core team, but with very little conviction. One of the things that also came up was whether the entrepreneurs themselves understood this well enough and believed that it can make a difference.
In my opinion, the key gap is in building a perceived value around this tool. It is about highlighting and celebrating successes. Early/core employees need to believe that if this thing works, they can make far more than they will ever earn (yes, even after accounting for high salary increases that we all experience). Towards that end, it will be good to get some success stories in response to this thread, where key employees have landed up making significant returns through ESOP in startup situations.
Also, would love to hear people’s thoughts on alternate incentive mechanisms that serve the purpose. In my opinion, the key attributes that such a mechanism must satisfy are:
- Alignment with value creation objectives of shareholders
- Retention effect/ Accumulation effect of rewards
- Ability to attract distinctly better talent, especially against large companies
- Performance orientation
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Thanks for that Alok, that provides some perspective. Yes, in the buyouts I’ve seen, apart from founders very few others have made tremendous money – the ESOP gainers have typically made money of the order of 5-50 lakhs. Maybe a crore or two. But that doesn’t inspire enough, because a) the chances of a startup making it huge is very very low and b) the payout doesn’t pay for the odds.
If you assume 5% chance of your startup hitting the big scene, 20% of it being break even (say an at par sale or some such) and 75% of it not making money, then what’s the esop worth? From history you make say 2 crores if it hits big. You make 20 lakhs if you kinda break even. And nothing for the rest.
Multiplying opportunity by odds, you make 14 lakhs (0.05*2cr + 0.2*20L) 14 lakhs is not a lot of money, pretty much worth a years salary for someone with 5-6 years of experience. For someone with more, the opp cost is probably negative.
What would make a difference? Someone making 20cr.+ in a big hit. An employee, through ESOPs. I’ve seen people do that – as founders – but not much as employees. Founders need to make 100cr.
We have to have success stories, otherwise ESOPs don’t matter. We gotta have more buyouts and more startups going public. We need bull markets to fuel the fire.
Till then, throw out esops. Keep them as spare change but it’s not possible, in my opinion, to hire quality people just on esops.
What else is needed to attract talent? Zoho’s ideas of 9 month training of people from the smaller cities, with the hunger and the drive, may just work. It won’t work in a short time frame that most investors seem to want, but if that can be relaxed you can get world class stuff out.
You can reward people on performance but it’s rare that in a startup there is any dollar value, initially, to performance. A revenue based incentive is akin to comp for sales people, and there’s enough research on that. Can’t really pyramid such things or pile them on because people want to see money now, not later.
So I think it’s money. Throw money, get talent. Throw esops too, but nothing big because no one cares anyway. But you want them there because if it’s a hit, it will form a precedent for esops on the next startup.
One thought: if VCs complain that startups don’t want enough money (and throw out the sub 2 million $ plans) and startups can’t attract talent with esops, why not simply give them more money for the same equity and throw money at the talent? Oh that’ll bring them, and the mercenaries, but who cares – eventually it’s a game of one big win, and if you have enough of the big talent across your startups your chances of scoring the big hit should increase.
I just don’t know who’s sitting on the other side buying the startups – unless it’s google, or microsoft or cisco.
There are plenty of people dying to work on exciting stuff for 16 hours a day and would still be happier with cash + equity/ESOPs rather than all cash. The only conditions are:
* Kick-ass product to work on. No, yet another social community thing will not qualify. Nothing less than world-class will. 🙂
* Open and trustworthy founders. “Inspiring leadership” in the MBA-speak 🙂
cheers
nilesh
From the chain of comments sounds like no one is making money in ESOPs in India. I think employees are better off who focus less on their job and more on flipping properties 🙂 I know of several people who have earned tens of lakhs/crores that way and they are not start-up material!
from personal experience with ESOPs, I got 1000 of those at $10 a piece when KPMG Consulting (BearingPoint) went public in 2001 in US. After few months I got a letter indicating I had 200 @ $50 a piece. Reverse split, was it?? My boss told me – “they screwed everyone”..never found out who were they and who were we!
Prashant,
Some basic flaws in your assumption –
a) In the unlikely scenario of VC buyout of employees’ stake, the money goes to the employee and not to the company. This beats the very purpose of “venture capital” – that is to inject momentum into the venture’s prospects, not for premature enrichment of employees before the venture itself has succeeded.
b) ESOPs are offered from *equity* – meaning all shares carrying equitable rights to participate in the fortunes(good and bad) of the company. Shares with liquidity preferences / differential rights are often abhorred by investors, to that extent they will reduce their funding. It is too complex a capital structure for startups to have anyway, because one of the first covenants of a VC term sheet will be to freeze all early liquidation options.
c)Employment bonds never work. Courts have held this to be in violation of Article 19 of fundamental rights granted under the constitution (right to occupation). Companies have tried hard but failed even as they showed enough evidence to prove that they have invested in training employees etc. But few have succeeded.
The right attitude to have while joining a startup is to have a parental instinct – to nourish it to health and do all it takes to give it a propulsion. For that one should have tremendous resilience and staying power with no great income. The reason why I always advocate “come to work in a startup after you’ve built a decent financial cushion” and not when there are mortgages to pay off.
Prashant, VCs like the team members to make money when they make money. Also, in startups, its not infrequent that companies raise money every 18 months, and that is too short a timeframe for exit. Note that while VC ownership may rise because of partial buyout (secondary purchases is not something VCs like), they again have to create a new pool to keep motivating the employees further on.